College Savings Plans

College savings plans can be a useful way to invest in your child's future. This article describes types of college saving plans, such as; prepaid tuition plans, Roth IRAs, 529 Plans, Coverdell Education Savings Accounts (ESA), and more,

A survey in 2008 conducted by Sallie Mae student loan organization found that parents have a range of responses to the expenses of sending a child to college, both in their willingness to take a financial leap to support their child, as well as considering college as an investment in the child’s future. Although parents overall value higher education, over half of families surveyed had rejected schools for their children on account of cost.

In order for parents who want their children to have a college education not to have to make unreasonable financial sacrifices on the one hand or rule out appropriate colleges based on finances on the other, investing in college savings plans can be a good choice.

Prepaid Tuition Plans

Prepaid tuition plans are college savings plans that allow you to purchase future tuition at current rates for a public, in-state college without having to have any specialized investment knowledge. But while these might look attractive, they give you less control over your contributions than in other plans, and you’ll get very little back if your child should happen not to attend college. Even if your child does get into college, having a prepaid tuition plan does not guarantee your child admission to the college you’re saving for.

Roth IRAs

Roth IRAs have some flexibility that a prepaid tuition plan doesn’t. Your contributions are flexible (though capped at $6,000 per year), and can be withdrawn when you want and for any purpose you come up with. In addition, after you’ve had the account for five years and attained the age of 59.5, your earnings are able to be withdrawn tax free. Note, however, that this may be a more appropriate choice for grandparents than for parents.

Mutual Funds

On the premise that a plan you use to save for college is a college savings plan, we consider individual mutual funds. This course gives you maximum flexibility in the choice of investments and freedom to contribute as much as you want and use your assets for anything you like. In addition, mutual funds don’t have a great influence on Federal financial aid formulas. On the other side, an individual mutual fund will not give you any college savings perks: your contributions are not tax-deductible, and you don’t get FDIC insurance.

US Savings Bonds

Tax incentives are one of the attractions to use savings bonds as part of your college savings plan. For some savings bonds that are earmarked for education, you never pay tax on the interest earned. An additional plus is that there’s no broker fee to buy them and you can purchase in small increments. The chief downside is the small return on your investment. It is usually suggested to use savings bonds in a college savings plan that has other strategies as well.

Custodial Accounts

Custodial accounts are simple to set up and can be created as savings, certificates of deposit, mutual funds, etc. They are not limited to education and become available to the child when they reach the age of majority (18 or 21), and then is under their control.

The downsides include the potential for the child to be taxed on unearned income at a high percentage rate if they have enough of it, and financial aid calculations will include the custodial account as money that the child should be contributing to finance educational expenses - that is, it doesn’t get the safeguards of some other types of college savings plans. Plus, there’s the whole matter of the child being in control, which some parents find problematic.

Coverdell ESAs

The new name for Education IRA, Coverdell ESA is an Education Savings Account. The account can be opened with a bank account, through a brokerage, or with a mutual fund company. The maximum yearly contribution is $2000, and earnings are tax free if they’re used for eligible expenses. When the student for whom the account is set up reaches the age of majority (18 or 21), control passes to him or her.

Limitations besides the gift cap (which gets lower as your income increases) include that the account must be empty by the beneficiaries 30th birthday, though the fund can be transferred to an eligible relative. There is a 10% penalty for using the proceeds for expenses that are not qualified.

529 Plan

Although it is the most widely recommended type of college savings plan, the 529 plan can be off-putting because there’s so much work for a parent to do to figure out which one to choose. Nearly every state, plus the District of Columbia, has its own version of a 529 college savings plan, and you can open one in any state. Most states offer a choice of direct investment and brokered portfolios.

Advantages of the plans include the large amount of allowed contribution, tax - deferred growth, and tax-exempt withdrawal, if the money is used for qualified education expenses. Your home state may offer you a tax deduction, and some states offer some amount of matching funds.

Things to watch out for are commission expenses, risk exposure that is either inappropriate for your child’s age (that is, the nearer you get to college, the more secure the funds should be) or simply inappropriate for you, and penalties for withdrawals not used for qualified education expenses, which incur penalties.